Who creates 97 per cent of the money in our economy? If you said the government or the Bank of England you’re wrong. It’s not a trick question but there’s more to it than meets the eye. The answer depends on which money you’re talking about. If you mean the coins and notes you take out the cash machine, then yes, the Bank of England creates that “real” stuff. But that only accounts for three per cent of the money we use in our economy. The other whopping 97 per cent is created by the private banks, which they lend to us and businesses in the form of loans and mortgages.

When you’re given a mortgage for example, the bank doesn’t hand you a suitcase full of used notes or a few bars of gold they brought up from their vault – chance would be a fine thing. No. They log into their computer, tap in the numbers on a screen equivalent to how much you want – like tapping numbers on a calculator – and press the transfer button. Hey presto, they’ve just “created” some brand new electronic money for you. Job done. It’s like the Bank of England says, “Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.”

In other words, the banks don’t lend us their own savings or anyone else’s savings like they used to in the olden days. They create new money that does not exist until they tap in the numbers on the screen. It’s true. Money doesn’t grow on trees but it does grow on computer screens.

“So what,” you say, “what’s the problem? This is how the economy works. The banks are providing a service and should be allowed to make a profit from it. That’s business.”

You’re right. Letting them create our money, lend it and charge us interest has become their business. But it wasn’t always like that.

And even if this is “how it is now”, that doesn’t make it right or good for us. We once stole people from their homes and sold them as slaves on the other side of the world. We once prevented women from voting. We once allowed pregnant mothers to take Thalidomide. We once thought smoking didn’t cause lung cancer. But when we realised these things were causing more harm than good, we did something about it. What is done is done but that doesn’t mean we have to carry on living in the same old, stupid way, suffering the same old stupid problems. What Henry Ford said a very long time ago still rings true today:

“If you always do what you’ve always done, you’ll always get what you’ve always got.”

And what we’ve got is private banks creating our money out of thin air and charging us for the pleasure of it. What a brilliant business model. Really. You have to hand it to the banks. This is genius. Sadly, like most things that seem too good to be true, there’s a catch. A big one. The problem with this way of creating our money is very simple: since banks make a profit from creating and lending us money, they have an obvious incentive to create and lend as much money as possible. What’s up with that you might say? The more money, the merrier right?

Let’s think about that for a second… does anyone remember 2007? Less than a decade ago.

The banks aren’t any better at creating and lending money than anyone else. In fact, they appear to be pretty bad at it. When the private banks created too much money before, it caused the financial crisis in 2007 that ended with taxpayers bailing out the Royal Bank of Scotland, costing us £45 billion, or £107 billion if you take into account bailing out the other failing banks too. Oh, and did I mention the other £17 billion it cost us to issue the government gilts that funded the bailout?

In other words, because of the profit motive, the private banks were creating far too much money, far too quickly, and making increasingly risky investments and loans. They couldn’t stop themselves and we didn’t step in until RBS was down for the count. This is not to be unexpected. The banks can’t help themselves because that’s their business model: they make astronomical profits from creating our money out of thin air and lending it back to us.

The more they create, the more profit they make. So they have no reason to stop creating it, especially when they know we will bail them out. We can put all the regulation we like in place, but the profit motive will still be there. The best way of stopping another crisis, is to stop them creating our money in the first place. Why leave the kids in charge of the sweet shop? It only leads to sugar-rush, tummy aches and teeth falling out. We need to face facts and do something about it. Creating money in this way has some pretty awful side effects:

It makes the banks too big to fail: since they create the vast majority of our money, and decide who to lend it to, they effectively have control over our economy and which parts of it will grow and shrink. But they’re only interested in lending to the sectors of the economy that offer the highest returns. Other parts of the economy which might still generate a return, albeit a lower one, go under-funded or starve. Despite this almost total control over our economy, the people who manage the banks aren’t democratically elected or accountable to us. That’s why Fred Goodwin, the former CEO of RBS, got away scot-free.

It means we have to insure the banks against their own risky lending, which means they aren’t private businesses after all: they’re propped up by taxpayers. But if they had to play by the same “free market” rules other businesses do, they would succeed or fail according to the quality of their decisions and productivity. And we wouldn’t have to insure them or bail them out.

It causes bubbles to burst. As Martin Wolf from the Financial Times points out, “…only about 10 per cent of UK bank lending has financed business investment in sectors other than commercial property.” That is, most of the money the banks create is thrown at the property market. The more money the banks create and lend in the form of mortgages, the more we can buy and sell property. Sounds good right? But wait, here’s another catch: this causes house prices to rise, so the banks have to keep creating and lending even more money, creating a debt and price bubble that always has to burst – although in the process, the banks make huge profits from the interest charges. There’s that profit motive creeping in again…

“House prices rise much faster than wages, which means that houses become less and less affordable. Anyone who didn’t already own a house before the bubble started growing ends up giving up more and more of their salary simply to pay for a place to live. And it’s not just house buyers who are affected: pretty soon rents go up too, including in social housing.”

Who is to blame?

This is not a witch hunt. Pointing fingers won’t change the past. The banks are creating our money because we let them and they’re being run by people with families just like you and me. They’re not monsters or James Bond-style evil geniuses. This is not a conspiracy theory either, this problem is much quicker and easier to solve than who shot JFK.

The only reason the banks are allowed to create our money is because we let them. There is no other reason. We have the authority and the opportunity to give someone else the power to create our money if we want to. We don’t need to ask the banks for permission.

If not the private banks, then who?

Easy. The Bank of England. Their mission is “to promote the good of the people of the United Kingdom by maintaining monetary and financial stability.” That’s why we trust them to create our notes and coins – 3% of our money. They could just as easily create our electronic money, the other 97%.

If we let them create 100% of our money, the private banks would then be free to operate like other normal businesses. The threat of their risky lending causing a housing bubble, or a crisis needing us to bail them out would be cured. Our politicians would finally be able to make independent decisions, free from the need to prop up the private banks. We would all have a more stable economy.

Ben Dyson, from Positive Money, explains how letting the Bank of England create all our money would work:

“The Bank of England would transfer any newly created money to government, who would either spend it into the economy, or divide it up between all citizens and make an equal payment to each of them. Banks would borrow money from savers and lend it to borrowers. If there’s a real shortage of money for business lending, then the Bank of England could create some to lend to banks for that purpose only, but not for mortgages etc.”

The Bank of England would decide how much money needs to be created at any given time. And since they wouldn’t be making a profit out of creating it, we could all be sure they were only creating the right amount and not fuelling a boom and bust, or doing it to please profit-thirsty shareholders. The banks would still be in business and making healthy profits because we’d need them to manage the payment transfer system: when one person or business wants to pay another. They’d also continue to trade in other financial assets and manage the process of allowing people to lend their savings to borrowers too. The banks won’t need to raid the piggy bank any day soon, that’s for sure.

Is this a right or left wing solution?

Allowing private banks to create money is not the invention of one political party. Neither is it a battle between capitalist or socialist ideology. This way of doing things has been the same for decades, existing under right and left wing governments, and under coalition ones too. Regardless of which type of government is in power, we will always need money to be created. It’s just a question of who should do it, when, and how much they should create.

The answer is simple:

If you want more bail outs, housing bubbles bursting and politicians afraid of making decisions that don’t prop up the banks, the answer is simple: carry on regardless.

If you want a better life, the answer is just as simple: tell your friends and family about how the banks are caught up in a dangerous cycle of making millions out of thin air that leads to boom and bust. Tell them how we can get the Bank of England to solve this problem. Tell anyone, anywhere right now! Because the more of us who know about it, the more of us will demand a better life.

Jack is a business and economics journalist and the founder of The London Economic (TLE).
He has contributed articles to The Sunday Telegraph, BBC News and writes for The Big Issue on a weekly basis.
Jack read History at the University of Wales, Bangor and has a Masters in Journalism from the University of Newcastle-upon-Tyne.